Solving Southeast Asia’s overvaluation epidemic

There’s an epidemic of overvaluation raging in Southeast Asia’s entrepreneurial community. It appears to be highly contagious, as most of the entrepreneurs we meet seem to be infected. Overvaluation is very dangerous for startups, and in extreme cases, it can be fatal.

Most of the startups that pitch to us in the region do a pretty good job – until they get to their valuation slide, where the presentation goes quickly and totally off the rails. One of my favorite examples is a fintech startup in Thailand that seemed to have it all: an innovative product, a strong team, and some good initial market traction. Then, the team started talking about how much money they were raising and at what valuation.

They were raising US$3 million, which I felt was very high for what was basically a seed-stage company. But that was nothing compared to their valuation.

I wasn’t sure I had heard the entrepreneur clearly, so I asked him: “Did you say US$16 million?” I felt it was already way too high.

“No, I said US$60 million,” he replied.

Game over.

Ironically, their product was supposed to help investors properly value publicly traded companies. When I asked the entrepreneur if he saw the irony in this situation, he replied: “Everyone has their view on valuation.” Indeed, I thought, they do.

That was an extreme case, but it’s fair to say that most of the startups we meet are improperly valued: most are way overvalued, while a sizable minority are undervalued. Of course, investors generally have a lower view of valuation than entrepreneurs do, but the difference I’m seeing here goes well beyond the normal spread in investor-entrepreneur valuations.

And it’s not just entrepreneurs who seem to be unable to value companies properly. I see many investors in the region also valuing investments at levels that virtually guarantee that these investments will not be profitable for them, even if they succeed.

Valuing any company is difficult, and valuing startups is even more difficult, so it’s not surprising that entrepreneurs and investors struggle with valuation. Let’s take a look at valuation methods for traditional companies to see what is causing the confusion, and then we can look at one method of valuing startups that actually makes sense.

Traditional valuation methods

Here are three methods that are typically used to value companies:

• Price to earnings (P/E): The company is valued as a multiple of its earnings, with the multiple chosen reflecting the company’s expected growth rate. Higher-growth companies are valued at higher multiples, and lower-growth companies at lower multiples.
• Comparables: The company is valued by comparing it to companies with known valuations and then adjusting for differences between the company being valued and the companies with known valuation.
• Discounted Cash Flow (DCF): The company is valued based on the discounted present value of its projected cash flows.

These valuation methods have been used for many years and are well understood. So why do they all fail when applied to startups?

VC method